International Economic Update

Global Growth SlowsSeptember 18, 2008

Global economic activity remains weak. Growth in many parts of the world has come in lower than expected in the second quarter, while it was stronger than expected in the U.S. The Organization for Economic Cooperation and Development revised its forecasts for the G7 economies with upward revisions to U.S. growth counterbalancing the downward revisions across the rest of the group (Chart 1).

Japan, the world's second largest economy, posted its sharpest drop in GDP in seven years, reflecting broad-based declines in consumption, investment and net exports. Declines in investment expenditures have weakened U.K. growth, which fell to 0.2 percent in the second quarter. In the euro area, growth contracted in the second quarter after stronger-than-expected first quarter increases, driven in part by the mild winter's positive effect on construction activity. Recent indicators suggest a further deceleration of activity in the region for the remainder of the year. Business and consumer sentiment indicators in Europe have continued to decline (Chart 2) while industrial production has weakened as well.

As for the U.S. neighbors, Canada and Mexico posted modest growth in the second quarter. In Canada, net exports and investments fell while both private sector and government consumption grew. Decreased U.S. demand for automobiles and lumber contributed to this decline in net exports.

Emerging economies continued to fare well relative to the advanced economies. China's growth in the second quarter came in at 10.1 percent, a slight drop from the previous quarter. The outlook is for continued strong gains, albeit at a slightly lower rate than last year. Export growth is expected to slow given softer external demand and further appreciation of the Chineserenminbi against major currencies. India's economy is expected to remain strong over the next year, but some deceleration is expected due to tighter monetary conditions. A recent 5 percent government wage increase is expected to fuel growth in consumption.

Inflation remains high in both advanced and emerging economies, despite the global slowdown in growth. In July, U.S. CPI inflation rose to its highest level since1991, and inflation rates in most economies with inflation-targeting policies are running ahead of central bank targets. However, inflation has moderated since July in many economies, in part reflecting falling, but still elevated, commodity and energy prices (Chart 3).

Trade with the rest of the world contributed positively to U.S. growth in the second quarter. Exports rose at the fastest rate in three quarters, and net exports contributed 3.1 percentage points of the U.S. economy's 3.3 percent growth rate (Chart 4). However, the contribution of net exports to growth is likely to fade in the second half of the year as the weakening global economy dampens demand for U.S exports.

The dollar has recently gained strength, sharply appreciating against the euro and pound (Chart 5). On top of weak growth abroad, the rising value of the dollar is likely to contribute further to shrinking demand for U.S. exports.

Faced with conditions of rising prices and sluggish growth, most central banks have held steady in their policy decisions (Chart 6). The European Central Bank has now kept its main policy rate at 4.25 percent for the past two months (August and September), and the Bank of England has left its rate unchanged at 5 percent since April. Japan and Canada have also kept their rates steady, while the Bank of Mexico has increased rates in its past two meetings. The People's Bank of China cut its policy rate, citing worries of a sharp growth slowdown as well as possible spillover from the financial turmoil in the U.S.